A cheap vol bet (yeah, right)?

It looked for a moment like there might be a flash crash yesterday, as Spooz dropped an almost unbelievable 14 handles in a matter of minutes after the open, representing something like an 8 standard deviation move by the standards of recent history. (Before you complain about Macro Man's shoddy math, that number was completely made up.)

Yesterday's core PCE deflator data ratcheted up in line with expectations to 1.5%, which is still below the Fed's ostensible (and frankly unrealistic, based on the last 15 years) target of 2%. Still, it was a step in the right direction, and a higher-frequency analysis clearly shows an uptick in the recent prints, as the 3m/3m annualized chart below indicates.

Still, before we get too excited it's worth noting that even this higher frequency reading is still below 2%, let alone the y/y changes tracked by the Fed. As an historical precedent, this measure was 2.4% when the Fed embarked on its previous tightening cycle, having breached 2% only a couple of months previously after the deflation scare of 2002-03. Macro Man would suggest that you'd need to this measure make a "higher high" than that observed in late 2011 for the Fed to feel comfortable about the inflation situation.

Elsewhere, Shinzo Abe no doubt poured himself a nice sake after Japan's labour market data posted its best reading in nearly a generation last night. At 3.5%, the unemployment rate registered its lowest reading since 1997 (pictured below), while the jobs-to-applicants ratio printed its highest reading since 1992. Regardless of the long term efficacy of Abenomics, you have to give the man credit for trying something new to make a difference, because in the short run, at least, it has.

What it means for the yen is a trifle unclear. In the old school world, good domestic data tended to be bad for the yen, as it signaled increased risk appetite amongst domestic investors, which usually resulted in yen selling for overseas punts investments. In the brave new world of QE and financial repression, however, good news can be seen as bad news insofar as it takes away the central bank sugar bowl (or crack pipe, or heroin needle, etc....) Certainly it is hard to see the BOJ re-entering the equation any time soon with data like this. Indeed, it's probably no coincidence that Kuroda and co. are shortening the duration of their rinban BOJ purchases.

It would seem, therefore, that there might be a bit of pressure for the yen to strengthen, at least absent a hawkish out turn from the US. Interestingly, USD/JPY is on quite an important level on the weekly ichimoku charts (see below.) Now, this charting technique involves a lot of mumbo-jumbo that Macro Man once tried to figured out in its entirety but gave up on. It is widely believed, however, that the Japanese love these charts, so you often see gaijin consulting them to get an insight into the locals' likely mindset on Japanese asset prices. As you can see, the weekly yen chart is threatening to break into "the cloud" for the first time since the Abenomics trade really got going in late 2012.

In theory, USD/JPY should either bounce sharply from this level or crash down to at least the bottom of the cloud, which currently resides at 96.14. Either way, the theory goes, USD/JPY could be due for a recent range-breaking move in short order.

And yet here we are with 1 month USD/JPY vol at all time lows, on a 4 handle! The one month straddle should retail for roughly 120 USD/JPY pips, which does not seem particularly cheap given the exceptionally low realized vol of the last few months but does look quite a bit better when you consider the inchimoku level noted above. Indeed, Macro Man has had reasonable success over the years taking long vol punts on assets that rest on critical technical levels, particularly those with at least some fundamental justification to move. With the 2 week straddle priced at roughly 70 pips, you can still recoup more than half your money even if nothing happens over the next couple of weeks (including any gamma scalping.)

It's hard to get excited about buying vol in the depths of summer with the business end of the World Cup about to start...but as potentially asymmetric bets go, this doesn't look like a bad one.

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The move in morning on the Spoos was caused by some stop hunting in EuroStoxx futures, IMO, which took out some daily levels. Stoxx have been weak here (iBanks in particular), but then of course the algo's came in after and scooped it up.

So how exactly would you do the Yen vol trade, buy the 1month, sell the 2 week and try to gamma scalp? (which I still am a bit fuzzy on)

It seems to me that there is some really sloppy buying going on out there - its almost as if they are not trying to minimize their market impact. Take yesterdays 50k 'spooz practically market order at the lowest volume point in the day yesterday - I trade enough size that if someone asked me to put on a $5bil notional bet I wouldn't jam it through in 10 minutes. Its just weird.

There are at least two ways that equity market dumps can begin. One way is after a decline in credit quality and a widening in risk spreads, which we haven't seen yet, even though risk seems to be mis-priced in a variety of credit markets. The other trigger occurs when a long slow rise in asset prices has been driven by a slow steady carry trade. As Polemic pointed out this week, once these carry trades cease to be profitable, they can correct suddenly. The leveraged nature of carry trades accounts for the rapid evolution of the subsequent unwind and the sharp elevator-like drops in price of risky assets that have been funded by these trades. As MM points out, It's quite clear that USDJPY and EURJPY has been driving the market since 2012 and so it makes sense to be focused on the charts of these risk proxies. June, July, August, who knows, Nico?

On the latter topic, it's worth noting that EURJPY has been below the 50 dma since mid May and below the 200 dma for most of June, and that the 200d is beginning to act as resistance. Without entering into a discussion of the infamous Death Cross, this is clearly a backdrop of increasing technical weakness, or JPY strength. The injection of QE-fueled inflation into the Japanese economy is clearly going to last a while, so those hoping for more yen debasement are likely to be disappointed.

@Leftback - you are referring to a USDJPY carry trade - but what part of that trade is generating the positive carry? I guess I'm confused what people are saying when they talk about it. Are they funding SPX purchases with JPY - if so thats a pretty ballsy bet with the ~2% carry well below the vols - its really just a directional bet at that point.

No, he means buy the 1 month straddle for 120pips, try to gamma scalp a little bit, and even if nothing happens, still be left with it worth ~70pips after 2 weeks (in line with what the 2 week one is worth now), i.e. you will have lost less than half your money in theta.

Christine Lagarde wants to extend the maturity of a bond that you happen to hold... you just can't redeem that short time bond for, let's say, thirty years...a... maybe 40, ah, maybe 50...

"Possible remedy. The preliminary ideas in this paper would introduce greater flexibility into the 2002 framework by providing the Fund with a broader range of potential policy responses in the context of sovereign debt distress, while addressing the concerns that motivated the 2002 framework. Specifically, in circumstances where a member has lost market access and debt is considered sustainable, but not with high probability, the Fund would be able to provide exceptional access on the basis of a debt operation that involves an extension of maturities (normally without any reduction of principal or interest). Such a “reprofiling” operation, coupled with the implementation of a credible adjustment program, would be designed to improve the prospect of securing sustainability and regaining market access, without having to meet the criterion of restoring debt sustainability with high probability."

C SaysOne has to laugh at Lagarde and her bald-faced cheek. Let us be frank, the manouvre is really all about trying to convert insolvency into recovery. The concept is if one is given long enough to repay no one need be insolvent because the lack of free cash will go away and future inflation will render the repayment fulfilled ,but relatively worthless in terms of purchasing power.